The brokerage firms and banks are implementing new SEC rules affecting money market accounts. We have reviewed the options and will change client money market accounts to the cash/bank balance choice since we believe it is the safest option for liquid funds.
Money market accounts are not glamorous since their returns typically trail bonds and stocks by a wide margin, but money markets perform a vital role in investment accounts. These accounts typically serve as "sweep vehicles" that receive the proceeds from security sales and dividend and interest payments. Investors also expect that money market positions will not lose value and are therefore a good place to store liquid assets that can be used to meet future obligations.
During the financial crisis, a few money market funds "broke the buck" as their per share values dipped below $1/share which caused additional stress throughout the financial system. This occurred since money market funds are mutual funds that hold securities whose prices fluctuate. Price changes are usually very slight since money market funds hold very short term bonds with high credit ratings. However, the financial panic of 2008, precipitated by the failure of Lehman Brothers and other financial institutions, caused the prices of bonds held in these few money funds to lose value.
Two years ago, the Securities and Exchange Commission (SEC) issued rules to try to prevent this situation from happening again. The main tenets of the rules focus on the following areas:
- Require the price of the money market fund to fluctuate based on the prices of the securities held;
- Allow the funds to charge fees or limit the redemption of funds (gates); and
- Increase disclosure concerning the fund holdings.
The underlying idea behind the rules is to force investors to acknowledge that their money market funds are subject to a degree of risk. That said, almost all money market investments are far safer than stock or bond funds will ever be since their underlying values will be very stable.
The SEC provided a few exceptions which dilute the beneficial impact that the above principles would have on the market. The SEC rules allow money funds to keep pricing at $1 per share if the funds cater to individual investors or the funds invest 99.5% of their assets in US Government Securities. These exceptions do not make sense since individual investors are the most likely to believe that their funds cannot lose value. Additionally, the SEC is allowing fund investors to assume that US Government Funds will never lose value which could happen if the credit quality of government bonds is threatened.
The banks and brokerage firms have responded to these rules by closing all their funds that will fluctuate in price and only offering government funds. The custodians are also offering cash options that function similar to bank accounts. Most of these cash options carry FDIC insurance limits since the underlying assets are held at one or multiple banks.
We recommend the cash/bank offerings since we view this choice as the safest option that is most likely to retain its value. Government money market funds are not allowed to fluctuate in value, but the fund companies may charge fees or erect gates to limit withdrawals. The cash/bank balances pay the lowest interest (currently 0.01% versus 0.1%); however, interest rates are so low that the interest payments will not be material in either vehicle. FDIC insurance also provides added protection of $250,000 per bank and up to $1.25 million for a custodian that uses five underlying banks. Therefore, we will switch all accounts to the cash option over the next couple of weeks before the change takes place in October.